State of Play: Senate Financial Reform

February 2, 2010 - by Donny Shaw

It’s been almost two months since the House of Representatives passed their bill (H.R.4173) to overhaul regulations in the financial markets and implement some of the lessons learned from the financial crisis. The Senate, on the other hand, still hasn’t taken up the issue. Since November, the Senate Banking Committee has been working to modify a draft version of a financial reform bill that was submitted by Chairman Chris Dodd [D, CT]. The committee has already missed several deadline for completing the bill and forwarding it to the full Senate, and they’re now looking at trying to get it done before the President’s Day recess, which begins on Feb. 12.

Here’s a quick state-of-play look at financial reform in the Senate —

Consumer Financial Protections

The proposal for a new Consumer Financial Protection Agency is one of the main sticking points. For most Democrats, the inclusion of a new Consumer Financial Protection Agency (CFPA) has become a sort of litmus test for whether or not the Senate bill contains any “real” reform. The CFPA is essentially a proposal for a new financial regulator that would look specifically at the safety and soundness of financial products for consumers. They would look at things like mortgages, car loans, pay day loans, credit rating agencies etc., and ban practices in those markets that are predatory and unfair to consumers.

Republicans don’t want a CFPA. Instead, they want to take some of the consumer-protection goals of the CFPA proposal and roll them under the jurisdiction of one of the existing financial regulatory agencies. Supporters of the proposal want an independent CFPA, arguing that any consumer protections will take a back seat to protections for the financial industry if they are give over to any of the existing regulators. There are rumblings that Chairman Dodd is willing to give up the CFPA in order to win Republican support for the overall bill and that several Democrats on the Banking Committee will go along with the decision to drop the CFPA, but no final decision has been announced yet.

Non-Bank Resolution Authority

Dodd’s draft bill calls for failing non-bank financial firms, like A.I.G., to be resolved by the Federal Deposit Insurance Corporation (FDIC) at the discretion of either the Treasury Department or a new Agency for Systemic Risk (ASR), but the final bill that is introduced in the Senate will probably make it a little harder for the government to take this action.

It would create a “presumption” that large, failing financial companies would have to go through a new bankruptcy process. This is different than what the White House proposed, which would give the government immediate control to put large, failing firms through a government-controlled resolution. The Warner/Corker deal would give the government the option to still put failing firms through a government-structured resolution, but they would have to clear hurdles first and it would be a bit more complicated.

This change was worked out between Sen. Mark Warner [D, VA] and Sen. Bob Corker [R, TN], but it’s pretty clear that Corker’s ideas prevailed during the negotiations, since the Republicans’ original Senate financial regulatory proposal contained a very similar bankruptcy resolution proposal for non-bank financial firms. Some Democrats worry that the extra bankruptcy court procedure for resolving these failing firms could slow down the process and create more bumps in the road for the financial markets in the case of such a failure. The FDIC is generally considered very good at their job. When they resolve failing banks — something they do quite often these days — it goes smoothly and neither the markets nor consumers feel the effects. This new bankruptcy procedure, some worry, could include resolution of things like derivative contracts, which the FDIC usually lets go, and result in a clunkier process.

Executive Compensation

Sen. Charles Schumer [D, NY] and Sen. Michael Crapo [R, ID] have been put in charge of deciding how to reign in executive compensation structures at financial companies that encourage unsafe levels of risk. The draft bill focuses on giving shareholders a non-binding vote on executive pay and golden parachutes. It would also require public companies to set their own policies to take back executive compensation if it was based on inaccurate financial statements.

This is generally considered pretty weak and it’s probably going to stay that way as the bill moves forward. Traditionally, the Democrats would be leading on this issue. But with NY Sen. Schumer leading at the helm for the Dems, the Senate is likely going to go fairly easy on Wall Street executives.

Regulating Derivatives

Sen. Judd Gregg [R, NH] and Sen. John Reed [D, RI] have been put in charge of writing the portion of the bill to regulate over-the-counter derivatives for the first time ever. The basic proposal in the Dodd draft bill was to bring some more transparency and safety to the derivatives market by requiring all derivatives to be cleared by a central clearinghouse and traded on exchanges. In other word, no derivatives would be traded “over the counter” (directly and privately between two parties) under the Dodd draft.

But Dow Jones reported recently that the language Gregg and Reed are getting ready to propose will require clearing of all derivatives, but won’t ban private trading:

Sen. Jack Reed (D., R.I.) said Thursday there is a " good chance" that the derivatives legislation he will soon recommend to the Senate Banking Committee will not contain a mandate to force swaps onto trading platforms.
Instead, the proposal is likely to contain measures to require traders to route over-the-counter derivatives through clearinghouses, which guarantee trades, and report them to a central repository after a trade is completed, Reed said.

“The sense we have is that we are just going to require a clearing platform, but not preclude in any way, shape or form an exchange platform,” Reed said in an interview with Dow Jones Newswires. “If the market wants to move to that, good luck. That’s a market decision.”

The lack of a trading provision for swaps is likely to win support from many in the financial industry who have argued that some swaps simply aren’t suitable for exchanges. But failing to include such a requirement runs counter to the financial overhaul package approved last month by the U.S. House. It is also at odds with the wishes of the Obama administration and Commodity Futures Trading Commission Chairman Gary Gensler, who has repeatedly called for forcing all routine swaps onto transparent regulated platforms.

Volcker Rule

This is sort of the wild card in all of this. This rule, named after former Fed Chairman Paul Volcker, says that commercial banks would not be allowed to own, run or sponsor their own hedge funds and private equity funds. It was introduced by Obama late in the Senate’s financial reform process and is not included in the Dodd draft bill. The Banking Committee is currently working on adding it.

However, [Banking Committee Ranking Republican] Mr. Shelby told dealReporter that he opposes the so-called Volcker rule and the Obama administration’s call to levy a tax on banks.

Mr. Shelby told the publication that if Democrats push forward with the proposals they risk unraveling much of the bipartisan support already reached regarding the passage of financial regulatory reform in the Senate. […]

A Dodd staffer told dealReporter that the senator is likely to quietly drop or modify many of the recommendations in the Volcker rule to ensure Republican support for regulatory reform.

“Chris is retiring so he wants to end his career with an important regulatory reform bill and he wants to make the bill bipartisan,” the staffer told the publication. “He is not going to risk bipartisan support to make the White House happy.”

Finally, here are a few resources for learning more about the Dodd financial reform draft:

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